The biggest risk with QE2 (in my view) is not runaway inflation. Its that trying to push more money to the real economy through a still-broken financial system wont work any better than it has so far.

Banks and investors still harbor rotting debt from the property boom. Much of this debt is still bound up in intricate legal and financial structures that still must be unwound before the kind of conclusive disposal that the economy needs to move forward can occur.

Yet QE2 allows regulators and politicians to believe  or pretend  that this mess will fix itself, if only the quantity of money is sufficient to levitate the housing and other debt-related markets. The alternative would be to confront the housing and banking horrors that fester under the fresh layer of money.

The economy suffers further damage as financial firms, in trapping all of the new money that the Fed is trying to push past them, further contort themselves and distort the recovery. Junk-bond issuance is at record highs this year, as financial firms and their clients try, in many cases, to cover up old bad assets with new bad debt. Underwriters are once again loading firms up with cheap debt, too, to extract huge cash dividends.

Its not “hyperinflation,” then, that is the clearest and most present danger, but the financial systems hyper-stimulation of itself as Wall Street continues to lack the motivation to re-learn how to talk and listen to the real economy.

Kevin Warsh, a Fed governor who voted for QE2, warned last week of a “new malaise” in a heartfelt speech titled “Rejecting the Requiem.” Read the whole thing, but here is an excerpt:

The prevailing theory has it that U.S. policymakers should not deny our foregone fate. We should accept smaller improvements in output and employment and productivity over the horizon. We should not stand before you and feign optimism or profess misplaced hubris. Instead, we should resign ourselves to the new normal now upon us, and conduct policy accordingly. In particular, central bankers in advanced economies  against a backdrop of disinflation  should be comfortably permissive in the conduct of monetary policy, still more encouraging of still more accommodative central bank policies for still longer periods. That is the last best hope, they argue, to preserve the remaining vestiges of a golden age that is no more.

Inflation would actually be preferable to halfhearted monetization of financial opportunism and political fatalism  at least we could measure it.